Earlier this month, I was at the Association for Public Policy Analysis and Management conference, where I participated in a community discussion about economic evaluation of public policy. During this conversation, we talked about the differences between evaluating effectiveness, efficiency, and equity of public policies.
It would be amazing if the most effective policies were also always the most efficient and equitable, but in reality we are faced with tradeoffs between these three goals. Do we prefer an efficient policy that only works on a small scale, or will policymakers stomach losing some efficiency to increase the magnitude of the result? What about a policy that is less effective overall, but does a lot more to improve equity–is this a tradeoff we would accept?
In cost-benefit analysis, one of the most important techniques for efficiency analysis, there is sometimes a desire to incorporate elements of equity analysis into the model. For example, if we include some measure of the diminishing marginal utility of income in a model, then whatever analysis we do will by default begin to suggest that more equitable outcomes (in this case those with less income inequality) are more efficient. Dan Acland, an economist from Berkely, has presented research on this topic at the annual Society for Benefit-Cost Analysis conference.
This begs the question, is it possible for cost-benefit analysis to go beyond efficiency analysis and also act as a tool for equity analysis?
One of the main concerns with attempting to include criteria other than efficiency into cost-benefit analysis is the difficulty that comes with trying to monetize equity impacts. Monetization is often one of the most challenging parts of cost-benefit analysis, and the further we get from goods that are actually traded in a competitive market the more difficult it becomes to understand how much people are willing to pay for certain things.
There are plenty of very rigorous ways to determine prices for things that are never actually bought or sold. Returning to the marginal utility of money example, economists have spent a lot of time researching and as a result we have a pretty good understanding of how valuable money is to different people.
Instead, if we were talking about how much people would be willing to pay to avoid experiencing racism, we would have a much more difficult time coming up with a reasonable monetary value. Maybe you could connect it to people’s willingness to pay for things like home security somehow, but that would clearly be a weak connection. Monetization of impacts is a great strategy for estimating efficiency, but it is not necessarily the best way to measure effectiveness or equity.
More importantly, it probably isn’t appropriate to ask the question how much are people willing to pay to avoid experiencing racism. Cost-benefit analysis is really good at measuring efficiency, but there is no reason to expect it to be able to handle big questions of morality.
What does all of this mean for cost-benefit analysis? I believe that cost-benefit analysis should monetize equity outcomes when it makes sense while still recognizing that it is not a form of equity analysis.
I think it makes sense to model the marginal utility of income in cost-benefit analysis because money can be used more or less efficiently by certain people. There are equity implications to that, but at its core the marginal utility of income is a question of efficiently allocating resources. However, saying income inequality is inefficient is not the same as believing we want to live in a society that distributes income more equitably. If we really want to care about the equity implications of policy decisions, then we need to dedicate time and energy beyond cost-benefit analysis.